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  • Darren Lindeman

China's economy, national debt and economic factors.

Updated: Jun 30, 2019

Management consultant Mckinsey stated ' China is starting its historic shift to a more consumption- and service-driven model that should help sustain the country's growth, albeit at a slower rate, over the next decade and beyond. As November’s 18th congress of the Chinese Communist Party showed, new government policies are helping to move the economy in this direction, even though investment—the historical motor of China’s growth—will still command the lion’s share of the economy in the near term.'.  China's transition to a consumer based economy factors in the transition from being a nation with historical high levels of household savings to one of greater aggregate consumption and spending. Greater consumption would lead to more demand for consumer goods and services and follow a consumer pattern more associated with western developed economies, which include innovative and service based industries.

As stated, China's economic development into the latter 21st century emphasized exports based industries to gradual development of a consumer based economy. After the Great Financial Crisis in 2008, the Chinese economy was supported by a credit boom to mediate funds fund seeking and providing agents after the recession. According to the IMF ' the (Chinese) nonfinancial sector domestic credit-to-GDP ratio, which was stable at around 135 percent before the GFC, increased sharply over the last decade to about 235 percent in 2016'. Besides the growth in cooperate debt there is also the growth of government and household debt. Bloomberg's stated in its article released on Serptember 2018 titled [China's debt bomb] , 'China's debt of public, household and cooperate debt has reached 34 trillion dollars'. 

China's economic miracle has been attributed to demand led by exports and government investments in industries or State Owned Enterprises. State Owned Enterprises played a large part in China's industrial revolution, serving as key economic agents for the state's fiscal policies. State Owned Enterprises accounted for USD 9 trillion of assets as of end of 2017, with China's GDP at 12.25 trillion USD at the end of 2017.  According to the same article 'Total SOE profits were 2.9 trillion yuan for 2017. SOE earnings declines were noted as a serious economic issue as SOEs were once profitable. " Overcapacity, poor corporate governance and low labor productivity had dragged down profits of China's SOEs". SOE earnings deteriorated sporadically between 2010 and 2015 with various years of lower profits and sporadic years of losses. 

However besides the transition into a consumption based economy, the Chinese government would also understand the importance of supply side structural reform and especially that of SOEs. " According to Lui He " the priority at the moment (of the Chinese Ecnomy), is to cut excess capacity where necessary, reduce inventory in the housing sector, bring down the overall leverage ratio, lower cost across the board, and strengthen the weak links in the economy, ranging from public services to infrastructure and institutions. Excess capacity has often been cited as a weakness in Chinese industrial expansion such as the over capacity of electrical power with coal. Excess capacity also increase the need for industrial investments, which would otherwise be not needed and invested somewhere else. SOEs had debts of 97 trillion yuan in December 2017, compared with total assets of 151 trillion Yuan according to the PRC Finance Ministry. This represents a leverage ratio of around 64.2 percent.

The outcome of lower  leverage ratios as opposed to higher leverage ratios partially implicate the role of credit issuance for Chinese businesses. Shadow banking is emphasized as an alternative to financing from Banks with greater regulations and lower risk apetites. Although high leverage means greater investment spending in the economy, the speculative nature of the Chinese economy (due to the role of government intervetion and other factors relating to price and information efficiency) should mean that business investment spending especially to unsustainable industries with relation to overall economic efficiency be reduced. Reducing unsustainable industries therefor would account for lower debt leverage ratios and financial injections into these industries. An efficient SOE based economy would also be allocatively, productively, competatively and price efficient. Despite being the second largest economy in the world, (the) Economist Intelligence Units latest Business Environment rankings, China places 50th in the worlds most investor-friendly location in 2014-18.

As Lui stated 'reducing inventory of the housing sector' is attributed to the investments in real estates and over supply of property. Managing China's property speculation and thereby prices should be considered central pillars of economic policy. As seen in previous local regional crises, volatile property prices would implicate greater systematic risks to the greater economy. Japan for example experienced a property bubble which caused an economic stagnation and deflation.  The need for a stable property market is especially true given China's household asset allocation in property as opposed to other financial instruments, which is approximately  65 percent in 2018.  A consistent property market would fuel household investment into a form of financing which is sustainable, and provides an incentive for a store of value. A strong government interventionist policy during times of volatile prices should be emphasized, with an effort to stabilize prices and improve market sentiments during times of uncertainty. 

As the stock exchange of Shanghai has grown to become second largest stock market in Asia and recently taking over Hong Kong's honory title. China experienced major stock volalitity in 2015 and the event was otherwise known as the 2015 Shang Hai stock market crisis. Although the influence of the event was downplayed by other positive economic outcomes such as that in GDP performance, the rapid and partially speculative driven -  rise and fall of the Shanghai Composite index implies the nature of market efficiency in China and whether or not the stock indice(s) are driven by fundamental performance or by over speculation. An overly volatile stock market would thereby impede sustainable economic development by increasing financial risk. The PRC would want to see that equity markets mature and become a second front for investment as opposed to property purchases.

As stated high national leverage ratios would impede economic health, especially that of SOEs. The PRC however has a centralized political authority to which it can act upon business obligations and contracts. A sustainable growth in GDP may be achieved by reducing more debt obligations simply by writing off debt or by structured facilities where reimbursements of debt can be repaid to creditors under certain conditions. If a corporation or cooperation can write off debt and not cause a negative financial multiplier, this should improve overall economic balances for cooperation and households allowing them to partake in more self oriented economic transactions, as opposed to for debt.